LoanDepot | Easy Money Martin

Online lenders were supposed to revolutionize the consumer loan industry. Instead, they are rapidly becoming yet another “the next subprime.”

We first started writing about the P2P sector in early 2015 with cautionary pieces like and “Presenting The $77 Billion P2P Bubble” and “What Bubble? Wall Street To Turn P2P Loans Into CDOs.” Things accelerated in February of this year when we first noted that substantial cracks were starting to show in the world of P2P lending, and more specifically, with LendingClub’s inability to assess credit risk of its borrowers that were causing the company to experience higher write-off rates than forecast.

Below is a chart that was used in a LendingClub presentation showing just how far off the company was in predicting write-off rates – the bread and butter of its business. It was evident then that their algorithms weren’t “working very well.”

At the time we said that what the slide above shows is that LendingClub is terrible at assessing credit risk. A write-off rate of 7-8% may not sound that bad (well, actually it does, but because P2P is relatively new, we don’t really have a benchmark), it’s double the low-end internal estimate. That’s bad. In other words, we said, the algorithms LendingClub uses to assess credit risk aren’t working. Plain and simple.

Three months later, in May of 2016, our skepticism was proven right when the stock of LendingClub – at the time the largest online consumer lender – imploded when the CEO resigned following an internal loan review.

Since then, despite a foreboding sense of deterioration behind the scenes, there were few material development to suggest that the cracks in the surface of the online lending industry were getting bigger.

Until today, that is, when we learned that – as expected – there has been a spike in online loan defaults by US consumers, sending a shockwave through the online lending industry: a group of online loans that were packaged into bonds is going bad faster than lenders and bond underwriters had expected even after the recent volatility in the P2P market, in what Bloomberg dubbed was “the latest sign that some startups that aimed to revolutionize the banking industry underestimated the risk they were taking.”

In a page taken right out of the CDO book of 2007, delinquencies and defaults on at least four different sets of bonds have reached the “triggers” points. Breaching those levels would force lenders or underwriters to start paying down the bonds early, redirecting cash from other uses such as lending and organic growth. According to Bloomberg, one company, Avant Inc. and its underwriters, will have to begin to repay three of its asset-backed notes, which have all breached trigger levels.

Two of Avant’s securities breached triggers this month for the first time, the person said, asking for anonymity because the data is not public. Another bond, tied to the subprime lender CircleBack Lending Inc., may also soon breach those levels, according to Morgan Stanley analysts. When the four offerings were originally sold last year, they totaled more than $500 million in size. Around $2.8 billion of bonds backed by online consumer loans were sold in 2015, according to research firm PeerIQ.

The breach of trigger points is merely the latest (d)evolutionary event attained by the online lending industry, whose fall promises to be far more turbulent than its impressive rise. Prior to the latest news, LendingClub last month raised interest rates and tightened its standards for at least the second time this year after seeing higher delinquencies among its customers, especially those with the most debt.

However, that was a linear deterioration which had no impact on mandatory cash covenants, at least not yet. With the breach of trigger points, online lenders have officially entered the world of binary outcomes, where the accumulation of enough bad loans will have implications on the underlying business and its use of cash.

Breaching triggers typically forces a company to divert cash flow from assets to paying off bonds instead of making new loans, which often means it has to find new, more expensive funding or to scale down its business. Avant, based in Chicago, cut its monthly target for lending this summer by about 50 percent, and decided to shrink its workforce in line with that, while CircleBack Lending, based in Boca Raton, Florida, stopped making new loans earlier this year.

Setting bond triggers is often up to the security’s underwriters. Some lenders have been working more closely with Wall Street firms to make sure the banks know how loans will probably perform and set triggers at reasonable levels, said Ram Ahluwalia, whose data and analytics firm PeerIQ tracks their loan data.

Indicatively, in the “old days” John Paulson would sit down with
Goldman Sachs and determine the “triggers” on CDOs, also known as
attachment and detachment points, so he could then be the counter party on the trade, and short it while Goldman syndicated the long side to its clients, also known as muppets. It would be interesting if a similar transaction could take place with online loans as well.

Other industry participants aren’t doing better: “There was a rush to grow,” said Bryan Sullivan, chief financial officer of LoanDepot, a mortgage company that last year began making unsecured loans to consumers online. In the true definition of irony, while Sullivan was speaking about the industry in general, LoanDepot’s own loan losses on a bond in September broke through the ceilings that had been set by underwriters at Jefferies Group.

We are not the only ones to have warned early about the dangers of online lending: Recently Steve Eisman, a money manager who predicted the collapse of subprime mortgage securities, said some firms have been careless and that Silicon Valley is “clueless” about the work involved in making loans to consumers. Non-bank startups arranged more than $36 billion of loans in 2015, mainly for consumers, up from $11 billion the year before, according to a report from KPMG.

And while P2P may be the “next” subprime, there is always the “old” subprime to fall back on to get a sense of the true state of the US consumer :as Bloomberg adds, the percentage of subprime car loan borrowers that were past due reached a six-year high in August according to S&P Global Ratings’ analysis of debts bundled into bonds.

Lenders themselves are talking about the heavy competition for customers. Jay Levine, the chief executive officer of OneMain Holdings Inc., one of America’s largest subprime lenders, said last week that “the availability of unsecured credit is currently the greatest that has been in recent years,” although he said much of the most intense competition is coming from credit card lenders.

And in a surprising twist, OneMain, formerly part of Citigroup, is taking steps to curb potential losses by requiring the weakest borrowers to pledge collateral. In other words, what was until recently an unsecured online loan industry is quietly shifting to, well, secured. Alas, for most lenders it may be too late.

* * *

For those curious, the deals that have or are expected to breach triggers include:

MPLT 2015-AV1, a bond deal backed by Avant loans that Jefferies bought and securitized.
AVNT 2015-A, a bond deal issued by Avant and underwritten by Jefferies.
AMPLT 2015-A, a bond deal backed by Avant loans and underwritten by Morgan Stanley.
MPLT 2015-CB2, backed by subprime loans made by CircleBack Lending Inc. and underwritten by Jefferies.

by Tyler Durden | ZeroHedge

We first noted Wall Street’s misguided plan to feed its securitization machine with peer-to-peer (P2P) loans back in May 2015 (see “What Bubble? Wall Street To Turn P2P Loans Into CDOs“). Obviously we warned then that the voracious demand for P2P loans was a direct product of central bank policies that had sent investors searching far and wide for yield leaving them so desperate they were willing to gamble on the payment streams generated by loans made on peer-to-peer platforms.

In addition to the pure lunacy of using unsecured, low/no-doc, micro-loans as collateral for a CDO, we pointed out that the very nature of P2P loans meant that borrower creditworthiness likely deteriorated as soon as loans were issued. The credit deterioration stemmed from the fact that many borrowers were simply using P2P loan proceeds to repay higher-interest credit card debt. That said, after paying off that credit card, many people simply proceeded to max it out again leaving them with twice the original amount of debt.

And, sure enough, it only took about a year before the first signs started to emerge that the P2P lending bubble was bursting. The first such sign came in May 2016 when Lending Club’s stock collapsed 25% in a single day after reporting that their write-off rates were trending at 7%-8% or roughly double the forecasted rate (we wrote about it here “P2P Bubble Bursts? LendingClub Stock Plummets 25% After CEO Resigns On Internal Loan Review“).

Now, signs are starting to emerge that Lending Club isn’t the only P2P lender with deteriorating credit metrics. As Bloomberg points out, less than year after wall street launched the P2P CDO, one of the first such securities backed by loans from LoanDepot has already experienced such high default and delinquency rates that cash flow triggers have been tripped cutting off cash flow to the lowest-rating tranches.

The $140mm private security, called MPLT 2014-LD1, was issued by Jefferies in November 2015 and, less than 1 year after it’s issuance, cumulative losses rose to 4.97% in September, breaching the 4.9% “trigger” for the structure. And sure enough, the deal was sold to a group of investors that included life insurance company, Catholic Order of Foresters.

But, as Bloomberg noted, the LoanDepot deal wasn’t the only one to breach covenants in less than a year. Two other Jefferies securitizations backed by loans made by the online startups CircleBack Lending and OnDeck Capital have also breached triggers.

For some reason the following clip from the “Big Short” comes to mind…“short everything that guy has touched.”